Thursday, November 24, 2011

Management of R&D - Reaction Paper No. 4


1. R&D Portfolio Development
A. “Portfolio Management for New Product Development: Results of an Industry Study”
(Summary) Portfolio Management pertains to the evaluation, selection, review, prioritization and resource-allocation of new and existing projects. It is the manifestation of an organization's business strategy and is of critical importance since an organization's business and future prospects depend on the success and merits of the projects it undertakes.  Specifically, the primary reasons why an organization must manage its R&D portfolio effectively is as follows: 1) to achieve financial goals, 2) to maintain, improve or gain competitive advantage, 3) to allocate resources efficiently, 4) to align projects with strategies, 5) to focus on key projects, 6) to balance short and long-term projects as well as high and low risk projects, 7) to communicate priorities throughout the organization, and 8) to be objective in selecting projects. Due to the importance of portfolio management, it is vital for an organization to adopt portfolio management methods. The most common portfolio management methods are as follows: 1) financial methods (e.g. NPV, ECV), 2) strategic approaches, 3) scoring models, 4) bubble diagrams, and 5) check list models. Financial methods and strategic approaches are the most often used as the dominant methods while the rest are primarily used as supporting tools. Financial methods are commonly employed to determine a project’s economic value but are also used to make “Go/Kill” decisions (by comparing against a hurdle level). Strategic approaches are used to classify and allocate resources to projects based on strategy and strategic priorities. Scoring models are primarily used as prioritization tools and are sometimes used to prioritize projects classified within the same category or bucket in Strategic approaches. Check list models are similar to scoring models in that they rely on a set of qualitative questions but are primarily used as “Go/Kill” decision-tools. Bubble diagrams are also commonly used as supporting tools due to its visual nature and the ease at which it conveys portfolio information. A study conducted to evaluate the effectiveness of portfolio management (measured against a specific set of metrics) in a number of firms found that the keys to effective portfolio management are: 1) having “a clearly defined, explicit, all-project, consistently applied portfolio management process”, and 2) a management (as a whole, in all functional areas) that “consistently and significantly view portfolio management as important.” The study also found that organizations that use Strategic approaches as their primary tool tend to outperform others. In addition, the study also suggests the use of a hybrid approach (i.e. combination of different methods) and incorporating a scoring model as a prioritization tool and bubble diagrams as a supporting decision tool. It also warns against over reliance on financial methods and the mechanical use of project scores in scoring models (since the real value is in discussion that arises as decision-makers walk through the scoring criteria).
(Reaction)  It is expected that strategic approaches are more effective that financial methods. Methods that encourage discussions and collaboration leverage the knowledge and expertise of the people involved. By consistently applying them (to all projects), the effectiveness of these methods get even better because they benefit from iteration; that is, they also leverage human learning and adaptability. As the evaluators get familiar with the process and the perspective of the others, their own knowledge and perspective expand allowing them to give better informed judgments. Moreover, with different perspectives, projects are evaluated more thoroughly and holistically. This is the same reason why hybrid methods work. Different methods focus or shed light on different aspects of the project. By using combinations, more sides (economic, strategic, long-term/short-term benefits, etc.) of the project are seen and exposed.

B. “Prediction markets as an Innovative Way to Manage R&D Portfolios”
(Summary) R&D portfolio management is critical process for most businesses but there are no well-established methodologies or tools to support it. Among the primary activities of R&D portfolio management is portfolio project selection.  It is a periodic activity that aims to optimize the research effort of the company by enabling it to select projects that are aligned to its strategic objectives and within its available resources. Different frameworks that have been proposed agree that the following are the primary functions of project selection: “1) maximizing the value of the portfolio, 2) achieving a balanced portfolio and 3) building strategy into the portfolio.” Traditional quantitative approaches are unable to support these functions due to weakness in 1) selecting the right criteria, 2) collecting the data, 3) and negotiating the portfolio between the different stakeholders. The aggregation mechanisms and information discovery process inherent in prediction markets appear to solve these issues. An R&D portfolio management prediction market behaves like a financial market (e.g. stock) wherein projects are traded in place of contracts or stocks and actors, directly or indirectly involved on the projects, from different functional areas (e.g. project leaders, project teams, senior management, people from marketing, finance, etc.) act as traders. Like stocks, projects (or project ideas) can be introduced to the market via IPO. The research proposes the use of specifically-designed prediction markets for each of the project selection functions mentioned above. The output of first prediction market (for  maximizing the value of the portfolio) is to be transferred to the second market (for achieving a balanced portfolio) while the third market runs continuously alongside the two such that information from this market can be used by the actors as indicators to support their trades in the other two markets. The equilibrium prices of the projects serve as their real-time valuation. The advantages of the proposed methodology are: “highly distributed and participative process, continuous actualization of the portfolio value, efficient and cost effective way to discover and aggregate the information disseminated between all actors and easy to understand resulting indicators.”
(Reaction) The proposed model is novel and interesting. However, certain issues need to be fleshed out and addressed to determine its suitability to R&D portfolio management. One issue is on the incentive and motive of the actors for trading. In a financial market, it is obvious; the traders trade for profit. In the proposed model, it is not clear why the actors would want to trade (the purpose of the model is clear – to come up with a valuation; but what’s in it for the actors?). A related issue is on the issue of manipulation. How can we guard against it? We can easily imagine a group (known or unknown) interested in a particular project conniving to inflate a project’s “value”. Finally and perhaps more fundamentally, the model appears to assume the efficient-market hypothesis and that value and price are interchangeable. This not even true for real financial markets and in fact, traders have exploited the “inefficiency of markets” for profit.

2. Strategic R&D Collaboration and Outsourcing
A. “Choosing Between Internal and Non-internal R&D Activities: Some Technological and Economic Factors”
(Summary) Non-internal R&D pertains to external R&D activities which are vertical in nature (i.e. customer-supplier relationship) such as outsourcing and quasi-external R&D activities which are horizontal in nature (i.e. competitive relationship) such as strategic alliances and collaboration. Non-internal R&D has the advantages of reduced cost/capital, reduced risk, reversibility (i.e. the firm can more readily change  path and direction) and separation from primary operations of the firm (thus, limited impact in case of failure) while internal R&D has the advantages of reduced opportunity for technological leakage (which results to loss of technological edge) and being able to deal with and take advantage of the tacit nature of innovation (i.e. accumulated, person-embodied skills). Like other non-internal activities in general, non-internal R&D activities increased in response to technological and economic factors. The increased reliance of firms to multiple technological competencies and the increased cross-border competition due to globalization mean increased R&D cost. In response, firms have turned to non-internal R&D. However, the increase in non-internal R&D is not at the same pace as the increase in the other non-internal activities due to reasons previously mentioned (uncertain and tacit nature of innovation, technological leakage). Even within non-internal R&D, outsourcing activities significantly exceeds collaborative/alliance activities. This is because while the principal reason behind outsourcing is economic like other non-internal activities in general, the principal reason behind alliance activities is strategic. Outsourcing is “undertaken where multiple, substitutable sources are available” and is “governed by the ability of firms to monitor” the quality of the provider (and its output). This implies that output (e.g. knowledge, technology) to be transferred is well-defined and available from multiple sources. For R&D alliances, the opposite is true i.e. the parties bring to the table unique or tacit inputs, which is precisely why firms go into alliances. A firm's technological competencies can be classified into distinctive, niche, marginal/peripheral and background. R&D on distinctive and niche competencies, which defines the firm's technological profile and competitiveness (large part in the former, small part in the latter) are mostly done in-house. Though niche competences, along with marginal/peripheral competences (i.e. technologies important to the firm in the past or in the future but it doesn't have a distinct advantage on them), are often subjects of R&D alliances as well. Background competences (i.e. technologies that enable a firm to utilize more crucial technologies but allocated only a small percentage of the firm’s resources) are usually outsourced along with some marginal/peripheral competences. The decision on whether to do R&D on niche competences in-house or with alliances and on whether to do R&D on marginal competences with alliances or through outsourcing is influenced by the stage of the affected technology's evolution. Three stages are identified: pre-paradigmatic (characterized by high uncertainty – new technology with no dominant design), paradigmatic (characterized by the rapid technical change but low uncertainty – relatively new but known dominant design) and post-paradigmatic (characterized by the low uncertainty and technical change – maturing technologies).
(Reaction) It seems that the same considerations (on the type and stage of a particular technology) can be utilized by multinational companies to decide whether to use a collaborative or outsourcing approach / model for internal projects worked on by teams across geographic locations. Such setup is especially common in software development companies; thus, it might be fruitful for them to review and perhaps, apply the presented framework.

B. “Innovation Through Global Collaboration: A New Source of Competitive Advantage”
(Summary) The increasing complexity of products in terms the number of technologies they include, the availability of cheap skilled labor and unique skills and capabilities in different regions of the world, and rise of open architectures and standards along with advances in development tools and technologies have made collaboration a competitive necessity. Realizing that collaboration is not outsourcing is key to the success a firm's collaboration effort. It is not merely a tactic for reducing cost by substituting one labor source with a cheaper one. Rather, to use collaboration for competitive advantage, it is necessary for a firm to: 1) develop a global collaboration strategy, 2) organize for collaboration, and 3) build collaborative capabilities. Developing a global collaboration strategy entails lowering cost systematically by reconfiguring operations to optimize performance. This implies leveraging superior capabilities (i.e. competences, expertise) and accessing contextual knowledge of its partners. Furthermore, a global collaboration strategy means aligning collaboration to the firm's business strategy. That is, focusing on how particular partners can increase the firm's business value. This allows managers “to understand competitive implication of partner selection by assessing their merits in multiple dimensions” and where to use collaboration in the innovation value-chain. Organizing for collaboration means adopting a collaborative model that considers the uncertainty (over the product and over the process that produces it) of the innovation process and thus, organizes team and management structure in ways that enable them to respond effectively (e.g. communicate effectively, retain of tacit knowledge, transfer knowledge efficiently, etc.) Building collaborative capabilities means making investments in people, process, platforms and programs.
(Reaction) The whole organization, especially the top management, must be committed to global collaboration to make it work since it requires major investments and organizational restructuring. Furthermore, there needs to be a clear and definite master plan detailing the necessary changes and activities (including those intended to address challenges and pitfalls such as technology leakage) to transform the organization into a collaborative one. Half-hearted and disorganized efforts might prove disastrous (rather than helpful).

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